Unit 3 and Unit 4

A convertible preferred stock with a par value of $100 is currently trading at $125 per share. The conversion ratio is 5:1. If the common stock is trading at $30 per share, what must the preferred stock's price be to be at parity? A)$150 B)$130 C)$70 D)$103

A)$150 The math is 5 × $30 = $150. The logic is, you can convert the preferred stock into five shares of the common. If the common is trading at $30 per share, to be equal, the preferred stock must be selling for five times that price.

ADJ Corporation's charter has authorized 10,000,000 shares of common stock. It has issued 5,000,000 shares and has 1,000,000 shares in its treasury. How many shares of common stock are currently outstanding? A)4,000,000 shares B)6,000,000 shares C)9,000,000 shares D)5,000,000 shares

A)4,000,000 shares Shares outstanding are those that are in the hands of the public. To determine the number of outstanding shares, take the number issued minus the number in the treasury. In this question, that is 5 million minus 1 million = 4 million. If, at a later time, ADJ should decide to issue some of the authorized, but unissued shares, the number of outstanding shares will obviously increase. The same would happen if the company sold some of the treasury stock in the open market or used it to pay stock dividends to current shareholders.

The basis of a bond with a 5% nominal yield maturing in twenty years and selling at 85 is approximately A)6.22%. B)5.88%. C)4.59%. D)5.75%.

A)6.22%. A bond's basis is its yield to maturity (YTM). It is not necessary to do the YTM calculation because it could only be one choice. We can easily compute the current yield by dividing the $50 annual interest by the $850 current market price. That is about 5.88%. The YTM must be higher than that because it includes the eventual profit realized when the bond matures at par. There is only one selection that is higher than 5.88%. The calculation would follow our formula of: Annual interest + (discount ÷ number of years to maturity) ÷ (Current market price + par) ÷ 2) Plugging in the numbers, we have: ($50 + ($150 ÷ 20 years) = ($50 + $7.50) divided by ($850 + $1,000 ÷ 2) = $57.50 ÷ $925 = 6.22%

Moody's Investment-Grade (MIG) rating would be applicable to A)a New York state revenue anticipation note. B)a New York state general obligation bond. C)a New York state university bond. D)a New York state revenue bond.

A)a New York state revenue anticipation note. A MIG rating is provided for short-term municipal debt commonly referred to as notes (revenue anticipation notes).

A term used to define certain alternative forms of debt financing, such as equity-linked notes (ELNs) and exchange-traded notes (ETNs), is A)structured products. B)principal protected products. C)high-risk investments. D)combination products.

A)structured products. In Notice to Members 05-59, FINRA defined a structured product as "securities derived from or based on a single security, a basket of securities, an index, a commodity, a debt issuance and/or a foreign currency." The most important thing for you to know for the exam is that these generally carry higher risk than other debt securities. These should be recommended only when the registered representative has a thorough understanding of the product and believes it is suitable for the specific investor. Yes, these are high-risk investments, but that is not the term used to describe them.

A corporation plans to make a public tender for 50% of its outstanding bonds. The price of the tender will be set by A)the issuer. B)the transfer agent. C)the trustee. D)the paying agent.

A)the issuer. In a tender offer, the issuer is offering to buy back all or a portion of the issue at a stated price. The price of the tender is set by the issuer although the issuer may engage an underwriter to help it set the price. This could happen when interest rates have gone up, causing the price of the outstanding bonds to fall. From a practical standpoint, this would mean the corporation paying off debt at a price below face value.

A corporation is having a rights offering. The terms of the offering require six rights plus $60 to purchase one share. With the stock's current market price at $74 per share, the theoretical value of one right before the ex-rights date is A)$0.23. B)$2.00. C)$0.20. D)$2.33.

B)$2.00. Because the question is asking about the value before ex-rights, it means we use the cum-rights (with rights) formula; that is, the market price minus the subscription price divided by the number of rights it takes to buy one share plus one. Plugging in the numbers gives us ($74 - $60) ÷ (6 + 1) = $14 ÷ 7 = $2.00.

The basis of a bond with a 5% nominal yield maturing in twenty years and selling at 115 is approximately A)5.75%. B)3.95%. C)4.35%. D)4.65%.

B)3.95%. A bond's basis is its yield to maturity (YTM). It is not necessary to do the YTM calculation because it could only be one choice. We can easily compute the current yield by dividing the $50 annual interest by the $1,150 current market price. That is about 4.35%. The YTM must be lower than that because it includes the eventual loss realized when the bond matures at par. There is only one selection that is lower than 4.35%. The calculation would follow our formula of: Annual interest - (premium ÷ number of years to maturity) (Current market price + par) ÷ 2) Plugging in the numbers, we have: ($50 - $7.50) divided by $1,075. That is 3.95%

The Union Fidelity Bank of Highville has issued jumbo CDs with a term of three years and a fixed interest rate of 3.5%. The minimum denomination of the CDs is $100,000, and the CDs are callable at 101% of face value beginning on the first anniversary of the issue date. Under which of the following circumstances is it most likely that the bank would exercise the call feature on that anniversary date? A)Three-year jumbo CDs are currently being issued with a fixed interest rate of 4%. B)Five-year jumbo CDs are currently being issued with a fixed interest rate of 2.7%. C)Three-year jumbo CDs are currently being issued with a fixed interest rate of 3.5%. D)One-year jumbo CDs are currently being issued with a fixed interest rate of 4%.

B)Five-year jumbo CDs are currently being issued with a fixed interest rate of 2.7%. As is the case with other fixed payment callable issues, whenever interest rates decline, it is generally beneficial to call in the older issue. In this case, the bank would pay an extra 1% to redeem but could refinance at a rate that is at least .8% lower and extend the maturity. We say at least .8% lower because with the new five-year CDs paying 2.7%, if the bank wanted to keep to the same final maturity date (two more years), it is expected that the rate on two-year CDs would be lower than that of CDs with a five-year maturity.

If a U.S. corporation wishes to issue eurodollar bonds, which of the following statements are true? I. The corporation will be subject to currency risk. II. The corporation will not be subject to currency risk. III. The issue must be filed with the SEC. IV. The issue need not be filed with the SEC. A)I and III B)II and IV C)II and III D)I and IV

B)II and IV Because eurodollar bonds are denominated in U.S. dollars, a U.S. corporate issuer will not be subject to foreign exchange risk, regardless of the country of issuance. In addition, because the bonds are issued outside the United States, the issue is not registered with the SEC.

Which of the following terms are associated with over-the-counter (OTC) trading? I. Market maker II. Specialist III. Auction market IV. Negotiated market A)I and III B)II and IV C)I and IV D)II and III

B)II and IV The OTC market is a negotiated market. Within it, market makers are broker-dealer firms that provide a source for stock that customers wish to buy and a repository for stock that customers wish to sell.

Which of the following is not a right conferred upon ownership of common stock? A)Dividends, if declared by the board of directors B)Limited liability C)Transferability of shares D)Voting in person or by proxy

B)Limited liability Although ownership of common stock means the holder's maximum loss is limited to the original investment, it is not a stockholder right. The doctrine of limited liability is a legal construct and shields stockholders from being responsible for debts of the company. Being able to vote the shares; being able to sell them without needing the issuer's permission; and dividends, if declared, are considered rights of owning stock.

One of your customers owns 100 shares of GTS common stock. The purchase was made two years ago at a price of $51 per share. GTS has recently declared a 3:2 stock split. At the customer's request, as soon as the new shares are in the account, you sell them and $2,000 from the proceeds of the sale is credited to the customer's account. Based on this information, the tax impact of this transaction is A)a long-term capital loss of $1,333 and a short-term capital loss of $667. B)a long-term capital gain of $300. C)a short-term capital gain of $300. D)a long-term capital loss of $1,400.

B)a long-term capital gain of $300. Immediately after the stock split, the total investment of the initial position remains unchanged at $5,100 (100 shares at $51 per share). After the stock split, the customer owns 150 shares (3/2 times 100 = 150 shares). Therefore, the adjusted cost basis per share is $34 ($5,100 divided by 150 shares). Those 50 shares were sold for $2,000 and have a cost basis of $1,700 ($34 times 50). That is a profit of $300. Alternatively, you could say that 50 shares sold for $2,000 represents a selling price of $40 per share ($2,000 divided by 50 shares), which is a $6 per-share profit ($40 minus the $34 cost basis). Fifty shares times $6 equals a profit of $300. The gain is long-term because the holding period of securities received through a stock split (or stock dividend) is that of the original purchase. If you have to guess, or are running out of time, when you see two identical numbers with the only difference being short- or long-term gain, in almost all questions, one of those two is the correct answer. Now you have a 50% change of guessing correctly and, if you remember that the holding period always begins with the initial purchase, then the odds are 100% in your favor.

If the dollar price of a municipal bond is 101 and, at that price, the basis is 6.10, the nominal yield is A)less than 6.10%. B)greater than 6.10%. C)exactly 6.10%. D)less than the coupon rate.

B)greater than 6.10%. Basis is a common synonym for yield to maturity, especially for municipal bonds. For any bonds trading at a premium, the nominal yield (or coupon) is higher than the basis (YTM). For bonds at a premium, yields from lowest to highest are as follows: yield to call, yield to maturity, current yield, and nominal yield.

When a corporation issues a debt security, the terms of the loan are expressed in a document known as the bond's deed of trust. The deed of trust is sometimes referred to as A)the loan agreement. B)the indenture. C)the bond resolution. D)the debenture.

B)the indenture. The indenture, sometimes also referred to as the deed of trust, states the issuer's obligation to pay back a specific amount of money on a specific date. A debenture is a debt security containing an indenture. Bond resolution is a term used for municipal bonds, not corporate debt.

Which of the following callable municipal bonds trading on a 7% basis is most likely to be called? A)6.5% coupon, callable at 105 in 2030 B)6.5% coupon, callable at 100 in 2030 C)7.5% coupon, callable at 100 in 2030 D)7.5% coupon, callable at 105 in 2030

C)7.5% coupon, callable at 100 in 2030 An issuer will call the higher coupon bonds before calling the lower coupon bonds. Of the two bonds with coupons of 7.5%, the one with the lower call price will likely be called first.

The SEC recognizes all of the following under the Credit Rating Agency Reform Act as being registered with the commission to rate debt instruments. Which of them historically has specialized in ratings for the insurance sector? A)Moody's B)Fitch Ratings C)A.M. Best D)Standard & Poor's

C)A.M. Best A.M. Best historically has specialized exclusively on the insurance marketplace. They issue financial strength ratings measuring insurance companies' ability to pay claims and rate financial instruments issued by insurance companies, such as bonds and notes. They can issue debt and financial strength ratings for other sectors as well under the Credit Rating Agency Reform Act.

The industry term "junk bond" applies to a bond with a Standard and Poor's rating no higher than A)B. B)C. C)BB. D)BBB.

C)BB. Once a bond's rating has fallen below the top four grades (AAA, AA, A, and BBB), it is no longer considered investment grade. At that point, BB (or Moody's Ba) or lower, it is considered a high-yield or junk bond.

A 10-year bond, callable in five years at par, is sold at a discount. Rank the following yields from lowest to highest. I. Nominal yield II. Current yield III. Yield to call IV. Yield to maturity A)IV, II, III, I B)I, II, III, IV C)I, II, IV, III D)II, I, IV, III

C)I, II, IV, III The lowest of all yields for a discount bond is the nominal yield (coupon rate), which is a fixed percentage of par. The highest possible return to the owner of a bond purchased at a discount would occur if the bond were called before maturity because less time must elapse for the investor to receive the discount.

It would be most unusual to see which of the following issued at a discount? A)Treasury bill B)Banker's acceptance C)Jumbo CD D)Commercial paper

C)Jumbo CD Jumbo (negotiable) CDs are one of the few money market instruments issued at face value. Unlike those issued at a discount, they are interest bearing.

The DCAV corporation has declared a 10% stock dividend. Which of the following is true regarding the shareholders receiving the stock dividend? A)The stock dividend would decrease their percentage of ownership within the corporation. B)The stock dividend would increase their percentage of ownership within the corporation. C)The stock dividend would not be taxable upon receipt by the shareholder. D)The stock dividend would increase the cost basis per share.

C)The stock dividend would not be taxable upon receipt by the shareholder. When a stock dividend is paid, the shareholders receive a dividend of additional shares instead of cash. The effect of this is an increase in the number of share with a reduction in the cost basis of each share. Because there is no monetary impact, there is no current taxation. The stock dividend would decrease their original cost basis. Although the stock dividend is not taxable upon receipt, it would be taxable upon the sale of the shares if sold for more than the adjusted cost basis. Stock dividends have no effect on a shareholder's proportionate ownership of the corporation.

The XYZ Corporation has issued some 4% callable bonds maturing in 20 years. The bonds are callable at 102 commencing in 10 years. Regarding these bonds, which of the following statements is not correct? A)XYZ will most probably call these bonds when it can refund the issuer at a lower interest rate. B)The bonds will likely be called in a declining interest rate market, forcing the bondholders to reinvest at lower rates. C)These bonds will appreciate faster in declining interest rate markets than comparable bonds without a call feature. D)The call premium generally will not compensate the bondholder for the loss of interest if the bond is called.

C)These bonds will appreciate faster in declining interest rate markets than comparable bonds without a call feature. All things being equal, callable bonds will not show as much appreciation in a declining interest rate market as bonds without a call feature. Logically, as interest rates fall, those bonds will be called making them less attractive than bonds where the higher interest rate payments will continue until maturity. It is correct that the premium ($20 in this question) is generally not going to equal the amount of interest that the investor would have been able to earn on the bond. It is some compensation, but not full. The bonds will be called when interest rates have declined, and the investor will now have the cash but faces the reinvestment risk of having to put the money to work at those lower interest rates.

A type of alternative trading system that trades listed stocks and is required to register with the SEC as a broker-dealer is A)a dark pool. B)an ETN. C)an ECN. D)the fourth market.

C)an ECN. Electronic communication networks (ECNs) are a type of alternative trading system (ATS) that trade listed stocks and other exchange-traded products. Unlike dark pools, another type of ATS, ECNs display order in the consolidated quote stream. As ATSs, ECNs are required to register with the SEC as broker-dealers and are also members of FINRA. Trading in the fourth market (institution to institution) is done largely through ECNs.

When a well-established corporation needs short-term borrowing for working capital needs, it will most likely issue A)a letter of credit. B)preemptive rights. C)commercial paper. D)a jumbo CD.

C)commercial paper. Commercial paper is the most common tool for corporations to raise short-term funds. A letter of credit is issued by a bank. On the exam, this would usually take the form of bankers' acceptances for those in the import/export business. Banks issue CDs, and preemptive rights are used for the sale of common stock. Stock is long-term capital.

All of the following statements regarding negotiable jumbo certificates of deposit are true except A)they are usually issued in denominations of $100,000 to $1,000,000. B)they usually have maturities of less than one year. C)they are fully insured in any denomination by the FDIC. D)they are readily marketable.

C)they are fully insured in any denomination by the FDIC. The FDIC insures only up to $250,000.

QED Corporation, whose common stock is currently selling for $90 per share, is having a rights offering. The terms of the offering require seven rights plus $83 to subscribe to one share of stock. Compute the theoretical value of a right on the ex-rights date. A)$1.125 B)$0.875 C)$7.00 D)$1.00

D)$1.00 Because this is ex-rights (without the rights), the formula does not include the "+1." The formula is (M −- S) N. Plugging the numbers in, we have ($90 −- $83) 7 = $7.00 7 = $1.00.

In which of the following will a change in interest rates cause the greatest price fluctuation? A)Series EE bond B)7% AAA-rated corporate bond with eight years until maturity C)7% AA-rated one-year municipal note D)7% 30-year U.S. Treasury bond

D)7% 30-year U.S. Treasury bond Price fluctuations are the greatest in bonds with the longest terms to maturity. The riskier the instrument, the more price volatility. Long-term bonds have greater risk than short-term bonds.

Which of the following are characteristics of negotiable (sometimes referred to as jumbo) CDs? I. They are issued in amounts of $100,000 to $1,000,000. II. They are always FDIC insured to face value. III. They are always mature in one to two years. IV. They trade in the secondary market. A)II and IV B)II and III C)I and III D)I and IV

D)I and IV Negotiable jumbo CDs are issued for $100,000 to $1,000,000 and trade in the secondary market. Most jumbo CDs are issued with maturities of less than a year. The FDIC insures up to $250,000 per account.

Two conservative customers in their 50s are interested in preserving principal and high-current income from their investments. From first to last, in which order are the following bonds ranked in meeting your customer's needs? I. Fort Worth Gas 5¼s of 35, rated A1 II. San Antonio Transit 5¼s of 35, rated AA+ III. Texas Telecom 5¼s of 35, rated AAA IV. Dallas Electric 5¼s of 35, rated AA- A)I, II, III, IV B)IV, III, I, II C)III, IV, II, I D)III, II, IV, I

D)III, II, IV, I Because the maturity and coupon rates are all the same, we can rank the bonds by rating. Based on the ratings given, the highest-quality bond is the Texas Telecom, rated AAA, followed in order by the bonds rated AA+, AA-, and A1.

Which of the following is not considered a debt security? A)Debenture B)Promissory note C)Equipment trust certificate D)Prior lien preferred stock

D)Prior lien preferred stock Stock, whether preferred or common, represents equity (ownership) and is never considered a debt security. The most common example of a promissory note on the exam is commercial paper, a money market instrument. Debentures represent an unsecured debt of the issuer. Equipment trust certificates represent debt secured by specific equipment, typically rolling stock.

Which of the following is true with respect to excess capital losses realized by an individual taxpayer? A)No more than $3,000 per year may be used against capital gains. B)They may be carried back up to three years and carried forward indefinitely until exhausted. C)They may be carried forward with a time limit of five years. D)They may be carried forward indefinitely until exhausted.

D)They may be carried forward indefinitely until exhausted. Any taxpayer is permitted to reduce capital gains with realized capital losses. If the capital losses exceed the capital gains, up to $3,000 may be deducted against taxable income. Anything in excess of that is carried forward and used against gains, or, if there are no gains, taxable income, again with a $3,000 annual limit. Those losses can be carried forward with no time limit until they are all used against gains or income.

When compared to statutory voting, cumulative voting gives an advantage to A)majority stockholders. B)management rather than the board of directors. C)participating preferred stockholders. D)minority stockholders.

D)minority stockholders. Cumulative voting allows shareholders to aggregate their votes and cast them as they please. For example, they could cast all of their votes for a single candidate. Cumulative voting makes it easier for a minority group of shareholders to gain representation on the board.

The Nasdaq Stock Market permits listing for all of the following except A)warrants. B)common stock. C)convertible bonds. D)nonconvertible debt securities.

D)nonconvertible debt securities. The Nasdaq Stock Market is an equity and equity equivalent market. Listed are common stock, preferred stock, warrants, limited partnerships, American depositary receipts, and convertible bonds. Straight debt securities are not part of Nasdaq.

All of the following securities trade in the over-the-counter (OTC) market except A)American depositary receipts. B)government and agency securities. C)Nasdaq securities. D)open-end investment companies.

D)open-end investment companies. Municipal bonds, government and agency securities, and corporate securities (listed and unlisted) all trade in the OTC market. Foreign securities trade in the United States if the companies comply with SEC registration and disclosure requirements. Mutual fund shares (open-end companies) do not trade.

A corporation pays a 10% stock dividend to common stockholders. All the following are true regarding this dividend except A)The dividend is taxable in the year the sale of the shares takes place. B)the cost basis per share is adjusted based on the stock dividend. C)the total value of the position is unchanged when the dividend is paid. D)the beauty of stock dividends is that they are nontaxable.

D)the beauty of stock dividends is that they are nontaxable. The stock dividend is taxable, but unlike cash dividends, which are taxed when received, stock dividends are taxable in the year the shares are sold. When the stockholder receives the additional shares, the cost basis is adjusted on a per-share basis with the total value of the position remaining unchanged. For example, if an investor owned 100 shares purchased at a price of $22 per share and the company paid a 10% stock dividend, the numbers would look like this. The number of shares owned is now 110 [100 + (10% of 100)] = 100 + 10. The adjusted cost basis per share (used when any of the shares are sold) is now $20 per share. The original cost is $2,200 (100 shares times $22 per share). After the stock dividend, the customer owns 110 shares, but there was no additional cost. Divide that original $2,200 by the new number of shares ($2,200 divided by 11) to arrive at an adjusted cost basis of $20 per share. The account value is still $2,200 (110 shares times $20 per share = $2,200).